Tuesday, June 9, 2009

This is a long-running theme I've been returning to time and again. From the very early stages of the financial crisis that began unfolding last September, it has been fashionable to say that banks had stopped lending, and that this was the proximate cause of the economy's collapse. I've taken pains to demonstrate that this was not true at all. This crisis had nothing to do with a shortage of money or a decline in bank lending.

To be sure, the growth in bank lending has declined, as these charts show, and loans outstanding have declined in the past 3-6 months. But as the charts also show, lending is still up at a handsome rate over the past year or two. It is also the case that all measures of the money supply, which are ultimately driven by bank lending (banks have the unique ability to create money in our fractional reserve system), are at or near all-time highs, and they are still growing (with the exception of currency which is now flat but still at an all-time high).

That loans outstanding have declined in recent months is not surprising at all, and in fact it is exactly what one would expect given the economy's weakness and the rise in bankruptcies and defaults. Everyone has been working very hard to deleverage over the past year, because leverage was a very bad thing to have had at a time when asset prices (e.g., equities and housing prices) were plunging. Many people and many companies and banks and hedge funds have been forced to deleverage by declining asset prices.

My main point continues to be this: there is no shortage of money out there. Our problems have nothing to do with a lack of money or a lack of bank lending. In fact, one of the big problems we face going forward is thatthere is too much money sloshing around the global financial markets. We know that to be true because all currencies are weak against gold. An ample supply of money has stopped the deflation train dead in its tracks: breakeven spreads on TIPS have surged. Now we will have to contend with an abundance of money that is likely to result in higher-than-expected inflation in coming years.

You are correct that those currencies have appreciated relative to gold from their all-time lows. But if you consider their value today relative to 1, 3, 5 or more years ago, they are all down versus gold by huge amounts. I look at the long-term trend, not the short-term fluctuations.